2. How should the fi nancial performance of a business be assessed?
There are three factors to look for when assessing the fi nancial performance of a business.
1
Profi tability How much profi t is the business generating? This is a good indicator of how well the business is being managed and its ability to survive and grow.
2 Liquidity
Can the business pay its short-term debts? If a fi rm has poor cash fl ow it may struggle to be able to pay its debts on time.
3 Gearing
Can the business repay its long-term debts? Businesses with large amounts of long-term debt need to be able to generate suffi cient profi ts to pay off their loans.
LO 2.13
3. How is profi tability assessed? The simplest way of assessing profi tability is to look at the gross profi t and net
profi t of the business. Are they going up or down? Is there a trend? There are also a number of simple calculations that you can do to assess profi tability.
Look at gross profi t as a percentage of sales
Businesses often look at gross profi t as a percentage of sales to help assess their profi tability. This is known as the gross profi t percentage (or gross margin). The gross profi t percentage measures gross profi t earned as a percentage of sales. The higher a fi rm’s gross profi t percentage, the easier it is to pay business expenses. Ideally, every business should be aiming for a steady or rising gross profi t percentage.
Formula
Gross profi t Sales
x 100
| Traction Bikes - Year 1 | Traction Bikes - Year 2 600,000
900,000 1,000,000 x 100 = 60% 1,500,000 x 100 = 60%
